Inflating Away the Debt? Not Really

According to popular opinion, a benefit of inflation is that it reduces the
debt burden by reducing the value of the currency in which the debt must be
repaid. An associated belief is that when the Fed and other central banks create
money out of nothing they are acting to "inflate away" the debt and are thus
performing a useful service on behalf of everyone who owes a lot of money.
But as is often the case when it comes to central-bank and government manipulations
of money and credit, there's a big difference between the way things are commonly
portrayed/perceived and the way they are in reality.

If the central bank and the government really wanted to inflate-away the debt
then they could do it by handing out money to everyone in proportion to each
person's existing holding of money. For example, a 20% increase in the money
supply could be effected by giving everyone a dollar for every five dollars
they currently held, so someone who previously had a $10,000 savings account
would suddenly have $12,000 in their account. Because the new money would be
spread throughout the economy in proportion to the original distribution of
money, and because everyone would be aware of what was going on, a broad-based
increase in prices (a reduction in the purchasing power of money) would quickly
follow the money-supply increase. This, we think, would be the least-harmful
way to inflate the money supply, and it could actually create a benefit to
most debtors (at the expense of most creditors).

However, the primary purpose of monetary inflation is NOT to inflate away
the general public's debt. Its purpose is, instead, to help or reward special
interest groups with the aim of attaining, or retaining, political power. As
we've explained in many earlier commentaries, the new money doesn't get evenly
distributed throughout the economy; it enters the economy at discreet points
and benefits the first users at the expense of everyone else.

In the US, the government is by far the biggest beneficiary of monetary inflation,
followed by the banks. Via the power of inflation, the US government has managed
to transfer massive wealth from the rest of the economy to the banking industry
over the past 15 months. It was also able to obtain for itself a large slice
of the US auto industry, and is now preparing to drastically expand its control
over healthcare and energy production/consumption. It's amazing what you can
accomplish when you can create, for yourself, an unlimited amount of legal
tender.

The money that the government creates for itself via the tool known as the
central bank will eventually ripple through the economy and find its way into
the bank accounts and wallets of average working men, but by that time living
expenses and interest rates will have risen by enough to more than offset any
possible 'benefit'. Moreover, the number of working men will be less, because
the economic distortions wrought by the monetary inflation will result in greater
unemployment.